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Ittner, Larcker, and Rajan (1997) studied the relative weights placed on financial and non-financial performance measures in CEO bonus contracts for a sample of 317

Ittner, Larcker, and Rajan (1997) studied the relative weights placed on financial and non-financial performance measures in CEO bonus contracts for a sample of 317 U.S. firms across 48 industries for 1993-1994. Non-financial performance measures include goals with respect to risk management, cost management, new revenue initiatives, financing, and development of U.S. operations. Financial performance measures are net income growth and return on equity.

Ittner, Larcker, and Rajan find empirical support for the following hypotheses about the relative weights on financial and non-financial performance measures in compensation plans:

i. Noise. The lower the correlation between manager effort and net income (measured by the correlation between stock market and accounting-based returns), the less the relative weight on financial performance measures.

ii. Firm strategy. "Prospector firms" (growth and innovation oriented, identify and adapt quickly to new product/service opportunities) will have greater relative weight on non-financial performance measures than "defender" firms (stable set of products/services, emphasis on increasing efficiency to reduce operating costs).

iii. Product quality. The greater the firm commitment to quality, the greater the relative weight on non-financial performance measures.

iv. Regulation. Regulated firms will have greater relative weight on non-financial performance than non-regulated firms.

Required:

Give intuitive arguments to explain these four hypotheses.

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